California: Some Gleam But Not All Glitter for Golden State Credit Unions

The California economy and its credit unions are staging a comeback, but the Golden State doesn’t glitter as brightly as it used to.

“I think it’s fair to say that for years, people in California didn’t seem to care what the rest of the country was doing, because it was a special, golden place that was immune to what happened elsewhere,” said California Credit Union League Chief Economist Dwight Johnston.

Now, he said, California is adjusting to a new reality that no longer includes guaranteed home price increases or plentiful jobs. For instance, Johnston said, the state used to enjoy a steady stream of manufacturing jobs producing products invented in Silicon Valley.

“Now we still have those new ideas, but the manufacturing has gone elsewhere,” Johnston said. “That was a sector of jobs California used to count on.”

That’s in addition to the construction jobs lost in the state when the bottom fell out of the housing market.

As of December 2012, California’s unemployment rate stood at 9.8%, well above the national rate of 7.9%. That’s an improvement over 2010 when the rate climbed to 12.4%, but historically, California had only seen double digits unemployment just once before the Great Recession, in 1980 when it climbed to 10.0%. In 2006, the state unemployment rate was just 4.9%.

Despite the economic challenges that lie ahead for the state, California credit unions produced an average return on assets that was just below 1%, at 93 basis points, which is above the national 86 basis points average. That income hasn’t come from lending, though: loan delinquencies are still higher than the national average at 1.8% and loan growth is nearly non-existent at 0.6% statewide.

Mark Hawkins, CEO of the $655 million Altura Credit Union in Riverside, said his 94,000-member credit union has adjusted to California’s new economic reality and can withstand the current economic and low rate environment for years to come.

But talk about a comeback: 2012 was Altura’s best year ever. The credit union raked in $17.49 million worth of net income, more than double the $8.43 million earned last year. Net worth increased to 10.36% as of 2012 year-end, higher than the national peer average.

Altura, located in the Inland Empire region of Southern California, was hit hard during the recession after a big housing and construction boom. Losses pushed net worth below 7% in December 2009 where it remained for eight consecutive quarters.

Hawkins said the Inland Empire is still struggling with 11.1% unemployment, home values still far below market peak, a sluggish job market and no consumer purchase appetite.

With no consumer or real estate lending activity, and few lucrative investment options, Altura managed to produce record income from non-interest income earned off deposit products and low expenses.

The credit union shuttered half of its retail branches and laid off approximately 45% of its staff in the wake of the financial crisis. Hawkins said the NCUA required the credit union to sell two wholly owned CUSOs – Patrion Mortgage and Patrion Insurance – and cease mortgage lending. Altura still isn’t booking mortgages for members, which makes the record income last year all the more impressive, considering it didn’t generate any refinance fee income.

Instead, Altura is making a go of it with auto lending, non-interest income earned off deposit accounts and a smaller, leaner organization with reduced operating expenses.

“Our expense posture is positive and our cost of funds is microscopic,” Hawkins said. “The only negative is consumer sentiment and the fact that we’re not seeing a lot of purchase activity from members.”

But, Hawkins said Altura has “never been stronger financially” and is structured to weather the region’s sluggish economy until things pick back up again.

Arrowhead Credit Union, also located in Riverside, is still being run under NCUA supervision after its June 2010 conservatorship. However, the $700 million institution reported a $25.5 million net profit and 10.53% net worth as of Dec. 31, 2012, yet another sign the Inland Empire economy is recovering.

Up in Northern California, Credit Union Times2010 Trailblazer CFO of the Year Scott Waite also reported record earnings at his $3.9 billion Patelco Credit Union. The Pleasanton, Calif.-based Patelco reported a $55.5 million net profit and 1.48% return on assets in 2012, and credited efficiency improvements and a mortgage refinance boom for the numbers.

Altura, Arrowhead and Patelco all have more than $500 million in assets, which provides them with economy of scale benefits. On the other end of the asset scale, small California credit union executives are partnering to achieve scale.

Jon Hernandez runs three credit unions in Southern California: the $55 million CalCom FCU of Torrance, the $28 million Mattel FCU of El Segundo and the $7 million City of Downey FCU in Downey. Not only does Hernandez save the three on CEO costs, he also shares compliance, technology and marketing executives with other credit unions, and collaborates with others to save on core processing systems, back office processing, health care benefits, marketing campaigns and staff training costs.

The largest of the three, CalCom posted a $389,975 profit for 2012, generating a 0.70% return on assets.

Because the credit union doesn’t offer mortgages, Hernandez said, it reported a relatively high loan yield of 8.78%. The credit union also extends loans to members with low FICO scores, which also drives up yield but necessarily increase losses. Hernandez said his delinquencies and charge offs are evenly split between high and low credit grade paper.

Loan growth was also above peer, 5.37% at 2012 year-end and peaking at 9.76% during the second quarter. Hernandez credits a lending department reorganization and revamped lending processes for the output.

“We didn’t necessarily increase the number of applicants, but we cross sell,” he said. Not only did loan staff cross sell additional loans, they also sold add-ons like GAP and MBP, which increased non-interest income.

Hernandez said he reduced operating expenses last year by renegotiating vendor contracts and eliminating some underutilized services, dropping operating expenses to average assets below 4% during the 2nd and 3rd quarters before settling at 4.16% at year-end. That’s a little higher than peer average, but Hernandez called the stat “considerably good” because the 7,423-member credit union operates four branch offices and eight proprietary ATMs.

He also signed on vendors to provide living trust and will services, auto insurance and retirement planning, which provided marketing agreement income. A new overdraft protection program also increased non-interest income. NII to average assets was 1.29% at Dec. 31.

Mattel FCU also reported a net profit last year, earning $44,025 with operating expenses slightly below peer but some loan delinquencies dragging down income and the common struggle of negative loan growth, which was -2.91% at year-end 2012.

The smallest credit union, City of Downey, reported a $31,314 net loss last year, and saw market share, loan growth, assets and membership growth all decline.

Johnston, the leagues economist, said California’s large credit unions dominate the state’s overall rosy numbers, but small credit unions still struggle to produce healthy financial reports.

Many credit unions below $1 billion in assets relied upon investment income that has all but dried up, he said.

“The big ones feel good about certain elements of their business. It’s not as bad as it used to be, but they generally struggle to maintain stable earnings and loan demand,” he said. “That’s the struggle now in California. Better than it used to be.”